Don’t confuse risk with volatility
When talking about risk, many investors are actually talking about volatility – the usual ups and downs of investment markets. When the actual return from an investment is lower than expected, investors believe that they have lost money in a physical sense. But in fact they have only lost money ‘on paper’. It is only when they actually sell the investment at the wrong time (when returns are at their lowest) that they permanently lose money.
When we talk about risk, we are talking about permanently losing money, not volatility. However the risk of an investment failing is not the only risk that you will face as an investor. Here are some other risks to be aware of:
1. Liquidity Risk
The risk of a delay in receiving your money when you need it. This can occur with certain types of investments where there is a lack of buyers (e.g. some unlisted
investments – those not listed on the stock exchange). Liquidity risk can also occur with investments whose underlying assets aren’t easily converted to cash.
Liquidity risk can also occur during periods of extreme volatility and extraordinary economic conditions. During the global financial crisis, for example, investors in a small number of managed funds wanted to withdraw their money at the same time. To protect the interests of all investors, the trustees froze the investments, placing restrictions on withdrawls.
2. Legislative risk
The risk that a change in the law results in an adverse outcome for you. For example changes to the superannuation or income tax laws.
3. Longevity risk
The risk that you do not accumulate enough retirement capital and you outlive your money.
4. Inflation risk
The risk that your money is eroded by inflation.
5. Interest rate risk
The risk that movements in interest rates adversely affect your portfolio. This can be a problem when investing in bonds (part of the fixed interest asset class).